Better Method College Funding for Grandchildren

Posted on March 8, 2012 by bobrichards

Much press coverage has been done on the new “529” savings plans as a vehicle for tax-free accumulation of money for college funding, and yes these plans are very attractive investment vehicles. But like all investment options, they have their limitations too, and for some investors there may be a better alternative for college funding.

Variable Life Insurance offers an alternative that offers additional flexibility for grandparents who wish to provide for their grandchild’s college funding and who potentially want to leave larger sums of money to them free of income and estate taxes.

This table provides a quick comparison:

529 Plans

Variable Life Insurance

Choice of Investments

No- once you pick your allocation, it's fixed for the duration

Yes- Wide variety of fixed and variable investment accounts that can be changed at will

Limitation on investment amount

Yes- most plans max out around $250K

No

Account remains in the control of donor

Yes

Yes, and you or your trust can designate another party to control your account

Included in the estate of the donor

Yes

Yes or No. If policy is owned by the owner, but if purchased via a trust or other party, then it is not included in the donor's estate

Death benefit to child if donor dies before completely funding account

No

Yes

Taxability of withdrawals.

Currently withdrawals for qualified educational purposes are free of federal tax. State taxation may vary. If money is withdrawn for any other purpose, amount is subject to income taxes plus penalties.

None, withdrawals are tax-free up to cost basis and loans are tax-free if policy remains in effect throughout donor's life. Death benefits are free of income taxes.

Gifting Power

$55K per year, per donor though this amount may be subject to taxes if donor dies within 5 years

$12,000 per year , per donor

Costs

Similar to mutual funds with an annual maintenance fee

Similar to mutual funds for the sub-accounts, plus mortality and expense charges.

A primary benefit of using VL for college funding includes a guarantee that your grandchild's education will be paid for if you die before fully funding the account. There is also no limitation on how you choose to spend withdrawals, loans or the proceeds from a life insurance policy. Thus, that money could be used for any purpose without the tax penalties assessed to money withdrawn from a 529 plan that isn’t used for qualified educational purposes (income taxes plus 10% penalty). This means that money could also be used to help your grandchild purchase a first home or anything else you deem suitable.

For whom is this approach best suited? Ideally you are in good health. The better your health the less expensive the cost of the life insurance part of the plan. Contact your insurance agent or retirement advisor to see if this is a good option for you.

Funding for college is a complex topic and it's essential that the parents see a college funding specialist. The amount of aid, grants and loans that the child can receive is highly dependent on how the parents structure their financial affairs. The grandparent's financial situation is not taken into consideraiton when a grandchild applies for grants, aid or loans. Therefore, the grandparents can play a big roe in funding for college.

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